Using a Roth IRA as an emergency fund

April 05, 2016

Did you know that all of the money that you contribute into a Roth IRA can be withdrawn with no penalty? It’s true, and it makes a Roth IRA account a viable secondary emergency fund.

No IRA penalties? Really?

You’re probably aware that if you withdraw funds from a Traditional IRA or a 401(k) before age 59 and a half, you pay a steep price: You pay a penalty on top of paying income taxes on the entire amount you withdraw.

A Roth IRA, on the other hand, is different. You don’t pay income tax on withdrawals from Roth IRAs, as long as they are considered qualified, because you’ve already paid income taxes on that money before you contributed it to your Roth IRA account. Now, granted, you do have to pay a penalty and taxes if you withdraw any earnings from your Roth IRA account, and a penalty if making an unqualified withdrawal before you reach age 59, or before the account has been open for five years (whichever is later), but the amount you contributed is yours, without penalty.

When withdrawing funds from your Roth IRA is a good option

OK, so we’ve established that you can withdraw the funds you’ve contributed into your Roth IRA without penalty. But should you? After all, the R in IRA stands for “retirement,” so it’s right there in the name of the account. And although it’s true that you should generally consider your Roth IRA to be a fund dedicated to retirement, a Roth IRA is a good option to use as a backup emergency fund in some circumstances.

We’re not suggesting that you should use your Roth IRA as your main emergency fund or that you should raid it when you have a flat tire or need a new clothes dryer. Having a Roth IRA does not cancel out the need for an easily accessible “regular” savings account for day-to-day emergencies.

When you think of your Roth account as an emergency fund, you need to keep the mindset that it is your secondary emergency fund, to be used only in an all-else-has-failed situation. We’re talking about the really big, major emergencies – extended unemployment, a looming bankruptcy, a foreclosure or a large one-time expense related to an illness or other crisis.

A personal example of my Roth emergency fund

The type of emergency in which you might use your Roth IRA as an emergency fund is the situation I was in when I learned about this option. Six years ago, I was in treatment for cancer during a reorganization at my previous employer. I was very worried about being laid off because I knew it was unlikely that my copayment-depleted emergency fund would last until I recovered enough to find a new job.

When I had my annual meeting with my Roth IRA broker and mentioned this worry, he pointed out to me that I already had a robust emergency fund because I had been contributing to a Roth IRA for nearly 10 years. He reassured me that the part of my balance that represented my contributions was mine to use, free and clear, if I needed it.

The knowledge that I had a backup emergency fund was very reassuring, so I’ve been contributing as much as I can to my Roth IRA every year since then. I’m simultaneously building my retirement savings and creating a financial safety net in case of a crisis.

Roth IRA next steps

“The potential to use early withdrawals from a Roth IRA to cover emergencies – or other financial needs, like college expenses – is one of the reasons that I’ve personally recommended Roth IRAs to many clients over the years,” said Joe Gaspari, a financial consultant with Alliant’s Retirement & Investment Services. “Saving via a Roth IRA gives you flexibility, because if you don’t need those dollars for emergency or educational needs, you just leave them in your Roth to grow – tax free – and you’ll potentially have more assets for your retirement.”

Gaspari added that the IRS sets income limits for eligibility to open a Roth IRA, and that whenever you’re considering making an investment in any account with taxable or tax-free consequences, he recommends that you consult with your tax advisor.

If you’re interested in exploring the features and benefits of a Roth IRA but you don’t know where to start, Joe Gaspari or another financial consultant from Alliant’s Retirement and Investment Services team can help. Your first consultation is complimentary and without obligation, and your advisor can help you to determine if a Roth IRA is a good option for you. Call 800-328-1935 today.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

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*Financial consultants registered with LPL Financial.